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ANALYSIS OF ANTITRUST ISSUES RAISED BY B2B EXCHANGES©

BY

ROBERT E. BLOCH
SCOTT P. PERLMAN
MAYER, BROWN & PLATT

FTC WORKSHOP ON BUSINESS-TO-BUSINESS EXCHANGES

JUNE 29-30, 2000


ANALYSIS OF ANTITRUST ISSUES RAISED BY B2B EXCHANGES©

BY

ROBERT E. BLOCH
SCOTT P. PERLMAN*

I. Introduction

A. In connection with its workshop on business-to-business (“B2B”) exchanges on


June 29-30, 2000, the Federal Trade Commission (“FTC”) has posed a number of
questions regarding the public policy implications of B2Bs, including:

1. What competition issues may be raised by B2B electronic marketplaces?


What are likely procompetitive benefits, and what are possible
anticompetitive concerns?

2. Under what circumstances are B2B electronic marketplaces likely to


increase or diminish competition? What has been the experience so far?

3. How do B2B electronic marketplaces affect entry at the buyer or seller


level? How does entry occur in the market for B2B electronic
marketplaces?

4. What issues are relevant to structuring and implementing B2B electronic


marketplaces in order to realize efficiencies and avoid competitive
problems? For example, what mechanisms might be included to prevent
inappropriate sharing of competitive, confidential information? Are any of
these mechanisms likely to be impractical or undesirable from a business
perspective?

5. Does the development of competition within and among B2B electronic


marketplaces depend in part on any intellectual property rights relating to
the design or operation of such marketplaces?

*
Mr. Bloch is a partner in the Washington, D.C. office of Mayer, Brown & Platt,
where he practices in the area of antitrust counseling and litigation. Prior to joining
Mayer, Brown & Platt, he was Chief, Professions and Intellectual Property Section,
Antitrust Division, U.S. Department of Justice. Mr. Perlman is a partner in Mayer,
Brown & Platt’s Washington, D.C. office, where he practices in the areas of
antitrust counseling and litigation, and Hart-Scott-Rodino compliance. Both Mr.
Bloch and Mr. Perlman currently are counseling B2B exchanges.
6. What implications, if any, do B2B electronic marketplaces have for market
structure and market concentration? (See “Public Workshop: Competition
Policy in the World of B2B Electronic Marketplaces,” 65 Fed. Reg.,
30120, 30122, (May 10, 2000)).

B. The following is a brief analysis of these issues as they arise in connection with the
following hypothetical:

1. A, B, C and D are 4 major wholesalers of toys (the “Wholesalers”).


Together they account for approximately 50 percent of all purchases from
toy manufacturers.

2. The Wholesalers propose to form a business-to-business on-line exchange


to facilitate transactions between themselves and both toy manufacturers
and retailers (the “Exchange”).

3. The primary purpose of the Exchange will be to eliminate costs from the
toy manufacturer-to-retailer supply chain.

a. The Wholesalers believe that use of the Exchange for on-line purchasing
will reduce transaction costs and facilitate “reverse auctions” -- in which
sellers are required to bid against each other for a purchaser’s business -
- that will result in lower product costs.

b. The Exchange also will provide data on orders and inventory to all
participants that they can use to manage production and inventory levels
in a more cost efficient manner. While most of this data will be specific
to the transactions being engaged in by the particular participant,
aggregated data concerning other parties’purchases also will be
provided. The data provided by the Exchange will include certain data
on orders and inventory that had been provided to customers by the
Wholesalers on an individual basis. The Exchange will provide this and
other data for a fee set by the Exchange’s board of directors.

c. In addition, the Wholesalers contemplate that the Exchange may engage


in certain joint purchasing activities on their behalf, and may combine
certain ordering and warehousing functions. For example, the Exchange
may create a common ordering system that will be used by all of the
Wholesalers, and may manage a process by which the Wholesalers’will
lease space to each other in their respective warehouses in order to use
available warehouse space in the most efficient manner possible.

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4. The Exchange will be governed by a 5-member board composed of one
representative of each Wholesaler as well as the CEO of the Exchange who
will be hired independently.

a. The Wholesalers will be prohibited from forming or taking an equity


interest in any competing exchange for 5 years after formation of the
Exchange, and will be prohibited from making purchases or sales
through any other exchange for 3 years, after which each Wholesaler
agrees to make 80 percent of both its purchases and sales through the
Exchange.

b. The Exchange Board may vote to admit other wholesalers as equity


partners in the Exchange. Such members will be required to adhere to
the same non-competition and purchase requirements as the
Wholesalers.

c. The Wholesalers also will encourage as many wholesalers,


manufacturers and retailers as possible to conduct transactions through
the Exchange. The Exchange Board will set criteria for participants,
however, including standard technology that must be used by all
participants and financial criteria.

II. Issues Raised by the Formation and Operation of the Exchange

A. The formation of a business-to-business marketplace like the Exchange by


competitors is analyzed as a joint venture or competitor collaboration under the
antitrust laws. See Antitrust Guidelines for Collaborations Among Competitors,
issued by the FTC and the U.S. Department of Justice (“DOJ”), April 2000
(“Collaboration Guidelines”). See also “FTC enforcers believe B2B auctions are
similar to JVs,” FTC Watch, April 10, 2000, 6 (report of discussion by David
Balto, Assistant Director, FTC Policy and Evaluation Office) (“Balto Article”).

B. The formation of a joint venture by competitors can raise two general categories of
issues under the antitrust laws:

1. Structural issues under Section 7 of the Clayton Act, which prohibits


mergers that are likely to substantially lessen competition or tend to create
a monopoly; and

2. Operational issues under Section 1 of the Sherman Act, which prohibits


conspiracies that result in unreasonable restraints of trade.

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C. The principal structural issues raised by the Exchange are:

1. Whether, by combining certain activities through the Exchange, such as


providing data to customers on orders and inventory, the Wholesalers will
be able to exercise market power, i.e., the power to raise prices above
competitive levels or to exclude competitors in any relevant market in
which they provide products or services; and

2. Whether, by combining certain purchasing activities through the Exchange,


the Wholesalers will be able to exercise monopsony power, i.e., the power
to drive prices for the purchased product(s) or service(s) below the prices
that would prevail in a competitive buying market, thereby depressing
output of the product(s) or service(s). See Collaboration Guidelines,
Section 3.31(a)

D. The principal operational issues include:

1. Whether the Exchange is a legitimate joint venture that will produce new
products or significant procompetitive efficiencies that the Wholesalers
could not have achieved separately, or a cartel formed to enable the
Wholesalers to fix prices, allocate markets or purchases, or commit other
anticompetitive acts.

2. Whether the Exchange will facilitate collusion among toy wholesalers with
respect to the prices of the products and services they sell to retailers,
among toy manufacturers with respect to the prices of the products they
sell to wholesalers, or among toy retailers with respect to the products they
sell to consumers. Such collusion could result from the operations of the
Exchange in a number of ways, including:

a. Wholesalers will purchase such a high percentage of their supplies


through the Exchange at the same prices that a large percentage of their
costs will become standardized, which will make collusion on the prices
of the goods and services they sell easier.

b. Participation by the Wholesalers in the governance and operations of the


Exchange, including meetings of the Board, will provide opportunities
to discuss the costs of supplies and the prices of the products and
services they sell.

c. Wholesalers will obtain access to data provided to the Exchange


concerning the prices at which competing wholesalers sell goods and
services to retailers, which information could be used by competing

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wholesalers both to reach an agreement on prices and to monitor
compliance with such an agreement.

d. Wholesalers will obtain access to data provided to the Exchange


concerning the purchases of competing wholesalers, including
information regarding the costs and quantities of such purchases, and
other cost data (such as the internal cost of warehousing space) which
information could be used by competing wholesalers both to reach an
agreement on prices and/or to monitor compliance with such an
agreement (e.g., by monitoring costs and, indirectly, quantities sold to
retailers).

e. Manufacturers will obtain access to data provided to the Exchange


concerning the prices at which competing manufacturers sell goods to
wholesalers, which information could be used by competing
manufacturers both to reach an agreement on prices and to monitor
compliance with such an agreement.

f. Retailers will obtain access to data provided to the Exchange concerning


the prices at which competing retailers purchase goods and services
from wholesalers, which information could be used by competing
retailers both to reach an agreement on prices for the products they sell
and to monitor compliance with such an agreement.

g. If one or more Exchange members at some point join a rival exchange,


the participation of these members in multiple exchanges will result in
collusion between the exchanges or members of the exchanges who
compete.

h. The Exchange is over inclusive, i.e., the number of wholesalers


participating is in excess of the number needed to achieve any plausible
efficiencies, and the large number participating makes the exercise of
market and/or monopsony power more likely and makes collusion
among the wholesalers easier to accomplish and more likely to be
effective in increasing prices.

3. Whether the agreements by the Wholesalers and other equity investors in


the Exchange not to form or become members of any competing
exchanges are reasonably necessary to the procompetitive purposes of the
Exchange, or are an unreasonable restraint on competition that will prevent
the formation of competing exchanges.

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4. Whether the commitment by the Wholesalers and other equity investors in
the Exchange to make all or most of their purchases and sales through the
Exchange will result in an anticompetitive degree of foreclosure to rival
exchanges and to manufacturers and retailers not participating in the
Exchange.

5. Whether criteria defined by the Exchange Board regarding which


manufacturers, wholesalers and retailers are permitted to participate in the
Exchange will result in excluded manufacturers, wholesalers and retailers
being unreasonably foreclosed from access to Exchange participants that
the excluded parties need to compete.

III. Impact of the Exchange on Competition, Entry and Market Structure

A. The threshold competition question regarding the Exchange is whether it is a


legitimate joint venture or a cartel formed to raise prices or engage in other
anticompetitive behavior.

1. A joint venture that constitutes an agreement by competitors to fix prices,


or allocate markets, customers or suppliers is per se illegal under the
antitrust laws; a legitimate joint venture is evaluated under the “rule of
reason,” under which the venture’s actual or potential procompetitive
benefits are weighed against it actual or potential anticompetitive effects.
See Collaboration Guidelines, Section 1.2.

2. A venture will be viewed as legitimate if it provides a new product or


service that the venture parties could not have provided acting separately,
or if it involves substantial economic integration likely to result in
significant efficiencies. See Collaboration Guidelines, Sections 1.2, 3.2.

B. Under these standards, it is clear that the Exchange should be considered a


legitimate joint venture. The Exchange will provide a new type of product or
service, an electronic marketplace available to all toy manufacturers, retailers and
wholesalers, that the parties cannot provide on their own, and that should produce
a number of significant efficiencies in terms of reduced transaction costs and more
efficient management of inventory and production.

C. Further, a business-to-business electronic marketplace like the Exchange has the


potential to increase competition among toy manufacturers, wholesalers and
retailers, lower entry barriers and decrease market concentration at all three levels
of competition.

D. Like the Exchange, most B2B exchanges with which we are familiar plan to create

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an “open platform” to which all buyers and sellers in their industry can gain access.

E. Such open access policies have the potential to make smaller buyers and sellers
more competitive by putting them on the same platform, and making their products
as easy to locate and evaluate, as those of better known rivals.

1. For example, a small toy manufacturer currently may not be able to


compete effectively for many sales because it lacks the sales force and
other resources to market its products effectively outside of its local area.

2. Access to the Exchange, on which its products can be offered to


wholesalers and retailers throughout the U.S. and perhaps the world may
enable such a manufacturer to compete for many sales currently beyond its
reach.

F. Decreased transaction costs also may encourage increased entry and expansion on
both the buyer and seller side in industries in which such costs are significant. In
the previous example, for instance, a small toy manufacturer may find it is
profitable to expand its plant or to open a new plant in a different part of the
country because it now can access additional sales.

G. B2B exchanges that lower entry barriers and increase the competitiveness of
smaller players also may result in decreased market share for established players.
The result should be a more competitive market with lower prices and better
quality products and services for consumers.

H. Of course, a B2B exchange only can produce these benefits if it is truly open.
“Open” in this context should not mean that the Exchange Board is required to
allow any party seeking access to have it, but rather, that the Exchange will
employ reasonable, objective criteria in determining who may participate (e.g., that
participants be able to use the technology being employed by the Exchange for
ordering and data collection, creditworthiness, etc.). See Allied Tube & Conduit
Corp. v. Indian Head, Inc., 486 U.S. 492, 501 (1988). On the other hand, if the
Exchange Board uses arbitrary eligibility criteria to prevent smaller manufacturers,
wholesalers or retailers from obtaining access to the Exchange, the Exchange
could have anticompetitive effects. See Allied Tube & Conduit Corp., 486 U.S. at
509-511 (affirming liability of fire safety association member for influencing
association to adopt biased safety code that favored member’s products).

1. As more and more transactions in the toy industry are conducted on the
Exchange, these smaller players would be marginalized increasingly, and
lack of access to the Exchange would become an ever greater barrier to
entry. See United States v. Terminal Railroad Association, 224 U.S. 383

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(1912) (railroad joint venture that owned and operated terminals violated
Section 1 of the Sherman Act by excluding non-member railroads from
using terminals where access to terminals was necessary for non-members
to compete).

2. Open access therefore may be a critical factor in ensuring that an exchange


plays a procompetitive rather than an anticompetitive role in the particular
markets in which it operates.

I. The importance of open access is increased when entry by additional exchanges is


difficult.

1. For a B2B exchange to form and operate effectively, it requires the


participation of players of a sufficient number and size at each level of
distribution involved, as well as access to the necessary software and
technology for the exchange to operate.

2. Access to the necessary software does not appear to be a problem. As we


understand the facts, several companies currently are offering or have
announced relevant software packages, including Oracle, Ariba and
CommerceOne, as well as a number of other companies.

3. Access to buyers and sellers of a sufficient size and number may present a
more difficult problem, however.

a. Thus far, it appears that exchanges in many industries are being formed
by a small number of significant industry players (e.g., auto
manufacturers, major airlines, major pharmaceutical manufacturers,
major retailers).

b. This suggests that formation of an exchange may require a small number


of large competitors to “anchor” the exchange and provide a sufficient
initial volume of transactions to make the exchange’s operations cost-
efficient as well as to attract additional participants.

c. In an industry in which all or many of such anchor participants already


have joined a particular exchange, the formation of additional exchanges
may be difficult.

4. In some industries, it may be the case that formation of a small number of


exchanges, or even one exchange, is the most efficient outcome. In
industries in which more than one exchange can function effectively,
however, provisions that prevent exchange participants from participating

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in rival exchanges or forming essential networks may raise entry barriers
for additional exchanges significantly.

a. Non-competition provisions that prevent exchange members from


forming or participating in rival exchanges can raise competitive issues
under Section 1 of the Sherman Act. In general, agreements by actual
or potential competitors not to compete are per se illegal violations of
Section 1. Where such an agreement is ancillary to the procompetitive
purposes of a joint venture, however, it is evaluated under the rule of
reason.

(1) The test is to show that the restraint is “reasonably related


to, and reasonably necessary to achieve” the venture’s
procompetitive benefits.

(2) To be “reasonably necessary,” an agreement need not be


essential; rather, it need only be the case that the parties
could not achieve equivalent or comparable procompetitive
efficiencies through “practical, significantly less restrictive
means.” Collaboration Guidelines, Sections 1.2, 3.2.

b. As described above, the Wholesalers forming the Exchange are


prohibited from obtaining an equity interest in or forming a rival
exchange for 5 years or conducting any transactions through a rival
exchange for 3 years, and are required to make 80 percent of their
purchases and sales through the Exchange thereafter.

c. To justify these restraints, the Exchange would need to be able to show,


for instance, that they were reasonably necessary to attract investors
who need some assurance that members will use the Exchange for a
sufficient volume of their transactions to achieve contemplated
efficiencies and make the Exchange profitable.

d. Even if the Exchange can make this showing, however, it still would
have to demonstrate that the restrictions are valid under the rule of
reason. Whether requirements such as those above covering these time
periods and thresholds are on balance anticompetitive will depend on the
facts of each particular industry.

e. If there are other significant wholesalers available to form rival


exchanges, these provisions may have little effect.

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f. If relatively few other significant wholesalers are available, however,
(e.g., if the Exchange is over inclusive in that it has more participants
than are needed to achieve procompetitive efficiencies, and leaves too
few wholesalers to form rival exchanges), these provisions, either
separately or as combined, could increase the difficulty of new entry.

IV. Managing Information Sharing

A. An important aspect of many of the exchanges currently being formed are the
types of information sharing described above in connection with the Exchange,
which have the potential to increase the cost-efficiency of the supply chain
significantly.

B. These information sharing activities also create a risk, however, that competitors
participating in an exchange will be able to use that participation to obtain access
to proprietary information regarding prices, costs and output of other competitors
that can be used to facilitate collusion.

1. Our experiences with a number of exchanges suggest that these concerns


can be managed through the appropriate use of devices such as pass codes
and fire walls that ensure that each participant’s access to non-aggregated
information is restricted to data concerning that participant’s own
purchases and sales. Such safeguards should be sufficient to ensure, for
instance, that one wholesaler can not access data indicating the prices
charged by competing wholesalers, or the costs of purchases made by those
wholesalers (other than when the wholesalers are engaging in legitimate
joint purchasing activities).

2. The parties forming an exchange can further reduce the likelihood that
improper information sharing will take place by promulgating strict
antitrust and confidentiality guidelines that provide, among other things,
that improper sharing of competitive information will result in severe
penalties, including possibly requiring equity members to sell their interests
in the exchange and/or prohibiting the offending party(ies) from being able
to conduct business on the exchange.

3. With respect to aggregated data like the data the Wholesalers contemplate
disseminating through the Exchange, the parties forming an exchange
should act to ensure that such information cannot be used to facilitate
collusion by adhering, where possible, to the safety zone for dissemination
of fee-related data among competing health care providers contained in
Statement No. 5 of the DOJ and FTC Statements of Antitrust Enforcement
Policy in Health Care (August 1996), including:

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a. The data should be collected by a third party (e.g., an outside
accounting firm or other consultant), or an employee of the exchange
who is not a current or former employee of any competing member of
the exchange;

b. The data should be more than three months old; and

c. There should be at least five parties providing data for each data point,
no individual party’s data should represent more than 25 percent on a
weighted basis for any data point, and the data should be sufficiently
aggregated so that they will not allow recipients to identify the prices
charged or costs of goods for any individual competitor.

V. Monopoly and Monopsony

A. Formation of a business-to-business exchange can result in monopoly or market


power in two different types of markets:

1. The market for exchanges in the industry being served by the exchange;
and

2. The markets for products and services in which the exchange participants
operate.

B. As noted above, in some instances, an exchange may be one of the few or even the
only exchange in its industry.

1. This may be due to internal growth, restrictions on member participation in


rival exchanges, mergers with other exchanges, or some combination of
these factors.

2. Under these circumstances, it may be possible for an exchange to exercise


market power by increasing the fees it charges participants for its services
and/or by reducing the quality of those services.

C. Where competing members engage in joint production, research or marketing of


products and services through an exchange, these activities can lead to the exercise
of market power with respect to those products or services.

1. For example, the joint provision of data regarding ordering and inventory
through the Exchange, some of which had been provided on an individual
basis by the Wholesalers, could result in the exercise of market power with

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respect to the fees for this data.

2. Such potential monopoly effects should be evaluated under the Horizontal


Merger Guidelines. Under the Merger Guidelines, principal areas of
inquiry would include whether (a) the venture will significantly increase
market concentration in the relevant product and geographic market, and
result in a concentrated market; (b) whether, in light of concentration and
other factors, the venture is likely to have anticompetitive effects; (c)
whether new entry or expansion by existing market participants will be
timely, likely and sufficient in magnitude to deter any anticompetitive
effects; and (d) whether the venture will produce efficiencies that cannot be
achieved by the parties through other means. Merger Guidelines, § 0.2.

D. Where members of an exchange contemplate engaging in joint purchasing activities


like those planned for the Exchange, they need to consider whether the exchange
will be able to exercise monopsony power.

1. In general, under the Collaboration Guidelines, joint purchases accounting


for 20 percent or less of the total purchases of any product or service in
any relevant market are unlikely to raise monopsony concerns, while
purchases exceeding this threshold need to be analyzed more closely.
Collaboration Guidelines, Section 4.2.

2. To the extent that joint purchases through an exchange appear to be


increasing to a level that could raise monopsony concerns with respect to
any product or service, the parties may be able to address these concerns
by:

a. Limiting the percentage of their purchases members are required to


make through the exchange of the affected product or service; and/or

b. Limiting the number of exchange members who may participate in such


purchases (e.g., by not allowing additional members to participate in
these joint purchases once purchases by existing members reach 30
percent of total purchases in the relevant market, or by rationing off
slots to participants through an annual lottery).

VI. Conclusion

A. The FTC has raised a number of important questions regarding the potential
competitive effects of B2B exchanges.

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B. As the analysis above indicates, the creation and proliferation of B2B exchanges
represents an important development that promises to bring increased competition
and more and better products to consumers at lower prices in a broad variety of
industries.

C. In order to ensure that the procompetitive potential of these exchanges is achieved,


however, careful analysis of the antitrust risks posed by an exchange, as well as
practical guidance regarding how to minimize or eliminate those risks will be
essential.

D. We hope that this article is a useful starting point for discussion in what promises
to be an ongoing dialog between practitioners and antitrust enforcement
authorities, both of whom are in search of ways to ensure that B2B exchanges
realize the significant efficiencies they promise.

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